Euro Area Economic Outlook April 2017

Euro Area: Election season has arrived

March 29, 2017

The Eurozone’s jam-packed 2017 election cycle is in full swing, taking center stage in market discourse. Results of the first vote in the Netherlands saw the country shrug off earlier worries that the far-right could make significant inroads as Geert Wilders’ Party for Freedom (PVV) lost by a sound margin. While the vote delivered a highly fragmented parliament, boding poorly for a strong and effective government, populist forces performed poorer than expected, suggesting that the threat to the Eurozone from anti-EU parties could be overblown. Overall, the country’s relations with the European Union should proceed largely as usual, reducing risks of political clashes over policy.

Next up on the agenda is major player France, which will hold the first round of the most uncertain presidential vote in its recent history on 23 April. Right-wing Eurosceptic Marine Le Pen is widely expected to move on to the final vote, though FocusEconomics analysts are confident that a more mainstream candidate will come out on top in the end and thus downside risks to the economy are marginal. For additional information on our analysts’ views see the results of our special survey. The common-currency bloc’s largest economy will also hold general elections later this year, which have the potential to facilitate a change in key Eurozone leadership. However, Chancellor Angela Merkel’s Christian Democratic Union party firmly won a regional election on 26 March, in an important test of mood among voters. At this stage domestic political risks in the region seem contained, however, following the number of shock election results in major economies in 2016, political surprises cannot be ruled out and clouds continue to loom over the region’s economic outlook.

Dutch Election: What economy will the new Dutch government inherit?

"On the face of it the Dutch economy is doing remarkably well, yet voters were clearly not entirely happy with the political status quo. While the Liberals do battle behind the scenes to form a working majority in the fragmented Dutch parliament, we take a look at the economic situation that the new government will inherit."

Against this backdrop of changing leaders, UK Prime Minister Theresa May will invoke Article 50 on 29 March, triggering the long-awaited Brexit process and sending the European Union and the United Kingdom into unchartered waters. Free movement of people between the island and the continent and the trade deal will be the cornerstones of the likely long and tough negotiations, which will shape the future of economic relations. Meanwhile, uncertainty persists over the future trading relationship with key partner the United States due to a lack of clear policy guidance from Washington.

Despite all the political noise concerning the Eurozone, the economic recovery appears to be approaching lift off. GDP growth picked up in the second half of 2016 on the back of solid domestic conditions and recent data suggest that momentum has firmed in Q1. Economic sentiment reached a nearly six-year high in February and the composite PMI also hit the highest level in almost six years in March. The FocusEconomics panel sees a strong start to the year with GDP growing 0.5% from the previous quarter in Q1, up from Q4’s 0.4% expansion.

Promising prospects for 2017

The FocusEconomics panel held its outlook for the Eurozone unchanged this month after last month’s upgrade. The panel sees the Eurozone economy growing a solid 1.6% in 2017 as an improving labor market and ultra-easy monetary policy support the domestic economy and the external sector benefits from a pick-up in global growth. However, rising inflation will take some wind out of consumption and growth will come in a notch below 2016’s 1.7%. For 2018, the panel sees GDP growth steady at 1.6%.

Looking at the individual countries in the region, 11 economies saw unchanged prospects, including France, Italy and Spain. Seven countries had their outlooks upgraded including Germany, Ireland and Portugal. Greece was the only country whose forecast was downgraded as recent data showed the economy on a feeble footing and the country continues to clash with creditors over needed reforms.

Luxembourg, Ireland, Malta and Slovakia are expected to be the fastest-growing economies in the region this year, all expanding above 3.0%. On the other side of the spectrum, Finland and Italy will be the region’s laggards, growing at around 1.0%. Among the remaining major economies in the region, Spain will outperform the rest by growing 2.5%. Germany is seen expanding 1.6%, followed by France at 1.3%.

GERMANY | Government wins sound victory in state elections

The German economy seems set for a solid first quarter in 2017, with data suggesting that Q4’s momentum extended into the new year. Industrial production swung back to expansion in January following December’s surprise contraction, which had largely been the result of seasonal factors. Business sentiment indicators continued to show signs of strength, implying robust industrial production growth and a recovery in business investment. However, consumer confidence dipped in March as households felt the bite of higher inflation, sparking fears that private consumption-led growth of the past few years could be coming to an end. However, such fears might be overstated as German households are generally in a sound financial position, benefiting from low indebtedness, respectable wage growth and a healthy labor market. On the political front, Chancellor Angela Merkel’s CDU won a resounding victory in Saarland’s state elections in March, while the SPD actually lost some ground. The result poured cold water on the notion that the SPD could coast to victory in the September federal election on the back of Martin Schulz’ popularity alone.

GDP growth is expected to slow somewhat this year, in part due to there being fewer working days. Higher inflation should also dampen household consumption growth and the subsiding refugee crisis will likely slow government consumption. Our panel expects GDP to grow 1.6% in 2017, which is up 0.1 percentage points from last month’s forecast. For 2018, the panel also expects GDP growth of 1.6%.

FRANCE | Economy key in election debate

Revised data confirmed that the French economy grew at a broadly stable pace in 2016 but growth came in far below the government’s more optimistic target of 1.4%. While the headline figure indicates a slight deceleration compared to the previous year, it hides positive developments in the economy. GDP growth accelerated markedly in Q4 and the latest indicators suggest that the strong momentum has carried over into this year. Unemployment in 2016 dropped to a four-year low as jobs grew at the fastest pace since the crisis, suggesting that the economic recovery is finally permeating into the labor market. Nevertheless, the latest positive data are insufficient to placate households’ general discontent and frustration concerning the economy. France’s electoral season starts on 23 April with the highly-anticipated first round of the presidential elections. Voters will cast their ballots again in June’s parliamentary elections, whose outcome will largely determine the power that the upcoming president will have during his mandate.

The economy is expected to accelerate this year and next on the back of a recovery in exports and solid domestic demand. Nevertheless, risks are tilted to the downside. The elections could spark uncertainty in the short-term and a weaker-than-expected global economic recovery could drag on export growth. Panelists participating in the FocusEconomics Consensus Forecast expect the economy to grow 1.3% in 2017, which is unchanged from last month’s forecast. For 2018, the panel foresees 1.4% growth.

ITALY | Uneven recovery continues in Q1

The economy sent mixed signals in the first quarter of 2017. Private consumption seems to have weakened, as retail sales declined for a second consecutive month in January and consumer confidence lost ground in February, likely dragged down by a stubbornly high unemployment rate. On top of this, industrial production fell in January, although partly due to a temporary correction after December’s strong pick-up. On the upside, business confidence reached an over-one-year high in February, boosted by higher confidence in the manufacturing sector, and the manufacturing PMI gained ground, underpinned by faster growth in new orders. Meanwhile, shifting expectations over the ECB’s monetary policy stance caused the country’s 10-year bond yields to rise to the highest level in over one-and-a-half years in mid-March. Higher borrowing costs does not bode well for the sustainability of the heavy public debt load or for the health of the country’s banking system, which owns a large share of the sovereign debt.

Economic growth this year is expected to remain subdued. Growth in private consumption should decelerate, as higher inflation eats into households’ income and rising financing costs put a lid on fixed investment. Analysts expect the Italian economy to expand 0.9% in 2017, unchanged from last month. For 2018, the panel sees growth of 1.0%.

SPAIN | Minority government hits roadblocks

Spain’s economy rounded out a year of strong growth in 2016, underpinned by solid domestic demand and a well-performing external sector. Economic momentum has not shown any signs of abating in the first quarter of 2017, with industrial output accelerating in January and sentiment among manufacturers and service providers reaching an 18-month high in February. Nonetheless, Spanish households have started to feel the pinch of rising inflation and stagnant wage growth, with retail sales in January declining for the first time in two years. In the political arena, a dock labor reform bill was voted down by the country’s fragmented parliament on 16 March, underscoring the hardships that the minority government has to confront if it intends to pass any legislation. However, the government has already rallied enough support to pass a 2017 budget, which is slated to be presented to parliament on 4 April.

Growth is set to experience a mild slowdown this year. Household consumption will moderate somewhat as the pace of job creation slows, wage growth remains muted and inflationary pressures mount. However, upbeat sentiment will encourage high capital expenditure, while the country’s exporting sector will continue to benefit from improved competitiveness and rising global trade. FocusEconomics panelists see GDP growing 2.5% in 2017, unchanged from last month’s forecast. For 2018, the panel sees growth easing to 2.2%.

INFLATION | Inflation rises over ECB target in February

Harmonized inflation came in at 2.0% in February, above January’s 1.8% and marking the highest reading since January 2013. Higher energy prices have caused inflation to rise above the European Central Bank’s target of close to, but below 2.0% for the first time in years. Rising price pressures led the ECB to strike a less dovish tone at its March monetary policy meeting, although it made no change to its policy stance. A number of our analysts think that the firmer economic momentum and rising inflation will cause the institution to announce a tapering of its bond buying program later this year.

Many of our analysts raised their inflation projections up a notch this month and the Consensus Forecast now foresees inflation of 1.6% this year, after a meagre 0.2% in 2016. The higher print will be driven by the diminished impact of low energy prices and reduced economic slack. In 2018, inflation is seen holding broadly steady at 1.5%.